Saturday, September 21, 2013

How to find relative strength stocks

A
client asks: “How do you select the
relative strength stocks? Do you check
one by one or do you have a tool?”

One of the best ways to find relative strength
trading candidates is to look for actively traded stocks which exhibit a
distinctive pattern of higher highs and higher lows in their 1-3 month chart
patterns when compared against the major indices. Arguably the best high-probability relative
strength set-up for a trade is to look for such patterns following a decline in
the S&P 500 Index (SPX). When the
SPX has made a series of lower highs and lows over, say, a 1-2 month period you
will often find individual stocks that have made higher highs and lows during
the same period. These stocks normally
reflect insider buying, since typically only the “smart money” is savvy enough
to purchase stocks in a broad market downtrend.
The assumption behind this pattern is that informed traders are “in the
know” and expect the stock to rebound with a market-beating performance once
the broad market decline bottoms out and reverses.

A good example of a relative strength stock in
recent months is EPAM Systems (EPAM), which in two different instances
maintained its relative strength position versus the S&P during market
pullbacks. The first such instance was
in the May-June period when the SPX made lower highs and lows while EPAM made
higher highs and lows. More recently,
EPAM made higher highs and low during the August broad market pullback, which
presaged its strong performance in September.

A fast way of checking for relative strength is
by simply going to Bigcharts.com and typing in the stock symbol (say for IBM)
and then selecting the "Compare To" button. This provides a
pull-down menu and you can either select an index for comparison (in this case
the S&P 500) or else type in a symbol of the stock, ETF or index of your
choice). The chart shows the price line of IBM compared against that of
the SPX (or whichever symbol you select). If the stock's price line is
above that of the SPX, then you can automatically see that it's in a relative
strength position -- especially if it has been outperforming the index for a
period of several weeks or months.